A company has a $10 million exposure to a particular risk. The company can reduce the risk
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A company has a $10 million exposure to a particular risk. The company can reduce the risk exposure by purchasing an insurance policy for $150,000 per year, which will cover 50% of the loss in the event of a loss occurring. Alternatively, the company can invest in a risk management system for $500,000, which will reduce the probability of the risk occurring by 20%. The probability of a loss occurring without any risk management is estimated to be 10%.
Assuming that the company is risk-neutral and only interested in minimizing expected costs, which option should the company choose and why? Show all the calculations and assumptions.
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